Standard and Poors - 0710

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Current Environment ............................................................................................ 1!

Industry Profile...................................................................................................... 9!
Industry Trends ................................................................................................... 11!
How the Industry Operates............................................................................... 15!
Key Industry Ratios and Statistics................................................................... 23!
How to Analyze a Supermarket or Drugstore Company.............................. 24!
Industry References........................................................................................... 27!
Comparative Company Analysis ......................................................... Appendix
This issue updates the one dated January 21, 2010.
The next update of this Survey is scheduled for January 2011.

Industry Surveys
Supermarkets & Drugstores
Joseph Agnese, Drug Retail & Food Retail Analyst
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INDUSTRY SURVEYS SUPERMARKETS & DRUGSTORES / JULY 22, 2010 1!
CURRENT ENVIRONMENT
Weak consumer demand spurs intense pricing competition
A weak economic environment in 2009 and the first half of 2010 contributed to increased sales and margin
pressure for food and drug retailers. Real gross domestic product (GDP) contracted 2.4% in 2009 as the
unemployment rate peaked at 10% in the fourth quarter of the year.
Rising unemployment intensified consumers price sensitivity. As a result, retailers experienced increased
demand for private-label goods, which sell at lower prices than branded products of similar quality, as
consumer traffic shifted to lower-priced retailing alternatives (such as discounters and warehouse clubs).
Consumers also altered their eating habits. Foodservice demand declined as consumers increasingly chose to
prepare more meals at home. Within stores, consumers sought out lower-priced food alternativesfor
example, trading down to chopped meat from the higher-priced steak alternative.
In response to the adverse economic environment, retailers took two-fold action. They decreased the shelf
space available for higher-priced branded products, while at the same time increasing their selection of and
the space available for private label alternatives. Industry pricing competition intensified, as retail operators
increased marketing and promotional spending in an effort to retain customer loyalty. Retailers tried to
appease customers with lower pricing during the weak economic cycle and hope to reap the benefits when
consumers eventually start to trade back up again.
The economic outlook is improving, in the view of Standard & Poors Equity Research. Real GDP is
forecast to increase 3.3% in 2010, as the unemployment rate stabilizes just below 10% before beginning to
improve at the end of the year. A more stable economic outlook is a factor that will help lead to increased
consumer confidence. In fact, consumer confidence rose to a 30-month high in June 2010, according to the
Reuters/University of Michigan consumer sentiment survey. Rising confidence is likely to lead to increased
spending as consumer demand improves and consumers begin to spend on higher-priced goods again.
Consumer data analysis to build loyalty
As retailers fought to defend their shares in a slower-growing market in 2009, they looked to gain an edge
on competitors. One such tool is customer data analysis. Many food retailers already collect consumer data
through loyalty shopping cards. To improve customer data analysis, some retailers are looking to outside
providers that can better organize and subdivide the data for more efficient use in marketing programs.
One company that specializes in such customer data analysis is UK-based Dunnhumby. In November 2009,
Metro, a Canada-based supermarket retailer, announced a joint agreement with Dunnhumby in an effort to
drive sales growth. Dunnhumby previously teamed up with US-based Kroger Co. to help it better operate its
loyalty card program. Through analysis of consumer purchasing data, retailers can improve the efficiency of
marketing programs (through targeted marketing), better control inventories (by stocking high-velocity
items that consumers want) and improve customer perception. With the hope of boosting customer loyalty,
retailers are looking to reap the benefits of increased investment in consumer data analysis when consumers
start trading back up to higher-priced goods in an improved economic environment.
Food inflation benefits to replace deflationary pressures
Deflationary food pressures hurt retailers sales results in 2009 and early 2010. According to the Bureau of
Labor Statistics (BLS), food-at-home prices rose only 0.5% in 2009, versus increases of 6.4% in 2008 and
4.2% in 2007. Key food categories around the perimeter of the store contributed to the slowdown in
inflation. The greatest price declines were seen in fruits and vegetables (2.1% in 2009), eggs (14.7%), and
dairy products (6.4%). Some of the largest price increases came in such categories as sugars and sweets
(+5.6%), and cereals and bakery products (+3.2%). In the 12 months ended April 2010, the consumer price
index for food at home was flat. Because food retailers manage their products based on gross profit margins
(rather than gross profit dollars), a deflationary product pricing environment hurts earnings.
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2 SUPERMARKETS & DRUGSTORES / JULY 22, 2010 INDUSTRY SURVEYS!
For 2010, the BLS projects the consumer price index for food at home to increase by 2.5%3.5%. A global
economic recovery is expected to lead to increased commodity and energy costs that, when combined with
stronger food demand, will pull inflation up from the low levels in 2009. Retailers are expecting that the
return of modest food inflation, combined with an improving economic environment, will lead to an
acceleration in sales growth and an expansion
of operating margins.
However, inflationary risks are high and food
retailers should remain cautious. For
consumers who remain price conscious in an
inflationary food environment, the increase in
shelf prices could result in additional trading
down, both to lower-priced alternatives and
to discount competition. If inflation is higher
than the low- to mid-single digits, food
retailers will likely have difficulty passing
along the higher costs fast enough, thereby
pressuring margins. Additionally, major
discount players such as Wal-Mart Stores Inc.
may choose to continue to take aggressive
positions on food product pricing to help drive
traffic into its stores. If such a case results in
lost traffic to stores, retailers may opt to
defend market share positions with aggressive pricing promotions of their own. Coupled with rising food cost
inflation, increased pricing competition would lead to significant margin pressures and hurt earnings.
CAPITAL EXPENDITURE BUDGETS MIXED IN 2010
In an effort to retain cash and strengthen their balance sheets in a severe economic recession, food retailers
curbed capital spending budgets in 2009. In many instances, expansion plans were reduced or delayed, with
the spending shifted to remodeling stores instead.
With a more stable economic forecast for 2010, however, retailers are beginning to increase capital spending
budgets again, in an effort to better their positions for a healthier retail environment. As expansion efforts
return, Standard & Poors believes merger and acquisition (M&A) activity within the retail food sector is
likely to increase as some retailers exit non-core markets and stronger regional players look to consolidate
within their existing markets. Additionally, improving credit markets are increasing potential acquirers access
to capital. SUPERVALU Inc., Caseys General Stores Inc., Safeway Inc., and Whole Foods Market Inc. are
each dealing with the operating environment in early 2010 in a different way, as discussed below.
SUPERVALU has taken steps to exit non-core markets while making progress on longer-term plans to
expand its discount format (Save-A-Lot) within existing markets. With sales under pressure, the company
plans to reduce capital spending to $700 million in 2010, from $750 million in 2009, as it focuses on paying
down debt and defending core market share positions.
Caseys General Stores is the target of a hostile takeover from Alimentation Couche-Tard Inc., one of North
Americas largest convenience store operators. The hostile offer, for a total enterprise value of $1.9 billion, is
scheduled to expire July 9, 2010. Standard & Poors Equity Research believes Couche-Tard is seeking to take
advantage of discounted asset valuations in a weakened economic environment, with the hope of benefitting
from improved scale.
Safeway plans to boost capital spending to a range of $900 million to $1 billion in 2010. While this
projected amount would represent an increase from the $852 million spent in 2009, it will still be significantly
less than the average of $1.6 billion spent annually in the 200508 period, when the company invested heavily
in updating its store base. Safeway has remodeled 79% of its store base since 2003, and plans to have 85% of
its store base remodeled by the end of 2010. Due to these investments, Standard & Poors believes the
Chart H01:
SUPERMARKET
SALES VS.
INFLATION
SUPERMARKET SALES VS. INFLATION
(Year-to-year percent change)
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
1995 1997 1999 2001 2003 2005 2007 2009
nflation rate* Supermarket sales
*Consumer price index for food-at-home
Sources: Progressive Grocer; Bureau of Labor Statistics.
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company is better positioned than competitors to operate at a reduced capital spending run rate before
neglected stores impact sales performance.
Whole Foods Market plans to increase capital spending significantly in 2010, to a range of $350 million to
$400 million, from $315 million in 2009. The planned budget is below the $430 million spent annually on
average from 2005 to 2008. The company continues to expand its store base, but has reduced both the
number and size of new stores it plans to open. A decrease in the size of new stores opened presents a benefit
in lower initial capital invested and provides a higher return on investment initially. However, the longer-term
returns are limited as the smaller stores reach capacity sooner.
Walmart reduces domestic expansion
Wal-Mart Stores Inc. cut back on domestic square footage expansion and increased its focus on a strategy
of offering everyday low prices in 2009. Although it reported a same-store sales decrease at its stores for the
fourth straight quarter in May 2010, the company continues to be the worlds largest retailer with over
$400 billion in sales in 2009.
Walmart projects total capital spending in the range of $13.0 billion to $15.0 billion in its fiscal year ending
January 31, 2011, up from $12.2 billion in the prior year. US capital spending is expected to rise to $7.0 to
$8.0 billion, from $6.6 to $6.8 billion. The majority of total capital spending (31% of the total capital
spending budget) is expected to cover new US stores, including expansions and relocations. Only $2.0
billion to $2.25 billion (15%) will be used on remodeling existing stores in the US. The new budget reflects
the maturity of the companys domestic business operations and growth potential internationally. Standard
& Poors expects an increasingly larger percentage of domestic spending to be used for store remodeling and
maintenance purposes as domestic expansion opportunities for the companys supercenter format become
more limited.
as it focuses on its productivity loop
Historically, Walmart has invested in information systems, self-distribution, and centralized procurement
capabilities to increase productivity, and to provide a more complete assortment of merchandise in its
stores. The company has also built a reputation as fair and honest with its everyday low price (EDLP)
strategy. The company aims to be the lowest-priced retailer in every product category in which it operates.
The lower prices seen at Walmart may not influence the buying decisions of all consumers. However, as
many of the companys customers are week-to-week wage earners, Standard & Poors believes Walmarts
ability to help consumers stretch their paychecks further is an important advantage for its stores. In
addition, Standard & Poors believes that the company leads its competitors in consumer awareness of its
low prices. To further boost awareness, the company began cutting prices on 10,000 items across its store
offerings in April 2010. In May, the company aggressively reduced prices on 20 high profile products in
order to strengthen its image of low prices and build customer loyalty at a time when consumers may be
beginning to trade back up to more expensive competitors. While other discount stores and supermarkets
may be close to price parity with Walmart, consumers perception is that Walmarts prices are still lower,
which S&P believes is usually the reality.
Because of its vast size, Walmart wields considerable power in its relationships with its suppliers, which it
leverages to its fullest advantage to ensure its costs remain low. The company relies on benefits from its
productivity loop to improve returns to shareholders. The company looks to reduce costs, enabling it to lower
prices, which results in increased sales volumes and increases cost leverage, allowing it to reduce costs further
and increase profits. By passing on the benefit of lower costs to customers in the form of EDLPs and price
rollbacks, Walmart has been able to increase its market share and attain worldwide leadership in retailing.
Due to a weak economic environment, the company increased its focus on its supply chain in an effort to
reduce costs in 2009. In an effort to leverage its transportation competency, the company, in fall 2009,
began contacting all of its manufacturers that provide products to its US stores. The company was seeking
to take over delivery responsibilities from suppliers in instances where Walmart believes it has the scale to
be more efficient than the manufacturers who produce the goods. In exchange for handling delivery of its
goods, Walmart was looking for manufacturers to reduce the prices charged for those goods.
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Previously, suppliers made most deliveries to the companys distribution centers. Once there, Walmart
would use its fleet of 6,500 trucks and 55,000 trailers to complete delivery of the goods to its stores.
Walmart plans to increase its use of contractors to help it meet the increased demand from the new initiative.
The company could benefit from improved on-time delivery performance, improved transportation
efficiencies by carrying full truckloads, and increase leverage benefits in fuel purchases. Savings generated
from a reduction in supply chain costs could then be passed along to consumers in the form of lower prices,
helping to improve sales growth and expand the companys market share.
Overly aggressive product assortment strategies reversed
Strategies focused on stock keeping unit (SKU) reduction became a commonly used tool in 2009 to expand
sales of wider-margin private label goods as well as improve cost control. Large retailers, including Walmart,
SUPERVALU, and Walgreen Co., have adopted product management strategies to significantly reduce SKUs.
A lower SKU count can lead to improved inventory control with fewer out-of-stock items on shelves, thereby
helping increase sales performance and boost efficiencies. Additionally, a more streamlined product
presentation can improve the consumer shopping experience, resulting in a boost in average basket sizes.
A reduction in the selection of SKUs available also provides retailers with space to expand their own private
label goods. However, elimination of branded products carries significant risks, including alienating customers
who have developed a loyalty to a specific brand. In fall 2009, branded goods manufacturers responded to a
weak sales environment by increasing marketing expenditures, helping drive increased consumer demand for
their products. As a result of potentially losing sales opportunities, some retailers, including Walmart, began
reintroducing branded products to their shelves in spring 2010.
NEW HEALTHCARE LAW POSES OPPORTUNITY AND THREAT TO DRUGSTORES
In 2008, 46 million Americans lacked health insurance, according to the US Census Bureau, a division of
the US Department of Commerce. President Obama overhauled healthcare policy on March 23, 2010, when
he signed into law the Patient Protection and Affordable Care Act. The new law will extend health
insurance benefits to 32 million uninsured Americans, according to Congressional Budget Office (CBO)
estimates. The CBO estimates that healthcare reform will have a gross cost of $938 billion over the next 10
years, excluding $115 billion in estimated discretionary spending. This reform presents significant
opportunities for retail drugstore operators.
Opportunities include expanded healthcare coverage
Standard & Poors Equity Research believes drugstore operators will benefit from an increase in individuals
covered by healthcare insurance, as it will accelerate demand for prescription drugs. By 2019, health insurance
benefits are expected to be available to 95% of all Americans, up from 85% as of April 2010. Expanded
health insurance coverage is expected to result in increased demand as the benefits will reduce prescription
costs for covered individuals, reducing (but not eliminating) the negative impact affordability plays in
prescription utilization.
Drugstore operators are well positioned for a shift in focus toward healthcare prevention and management
and drug adherence programs. Their drugstores have convenient locations and accessible pharmacists; and
drugstore clinics offer an alternative to the services provided through emergency rooms and doctors offices.
These clinics are also well positioned to provide increased healthcare services, including preventive health
screenings and programs to promote wellness and healthy living.
elimination of Medicare Part D doughnut hole
The new legislation will eliminate the gap in Medicare Part D by 2020. The Medicare Prescription Drug,
Improvement, and Modernization Act of 2003 provided drug coverage for people eligible for Medicare. Under
the 2003 legislation, after meeting a $250 deductible, insurance covered 75% of prescription drug costs up
to $2,250. Between $2,250 and $5,100 (the so-called doughnut hole), no coverage is provided; Medicare
then picks up 95% of all costs above $5,100. The new healthcare bill will gradually close the doughnut hole
for those eligible for Medicare. Elimination of the doughnut hole is expected to result in benefits for
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pharmacies due to increased demand from the Medicare participants that would otherwise have incurred
increased costs after exceeding the lower limit.
and reduced threat from reduction in Medicaid reimbursement
The new healthcare law reduces the threat that could have been caused by a reduction in pharmacy
reimbursement rates for dispensing generic drugs covered by Medicaid. Medicaid reimbursement levels for
generic drugs were scheduled to decline (but had been delayed by litigation) below the drugs acquisition
costs under a program dictated by the Deficit Reduction Act of 2005, which was signed into law by
President Bush on February 6, 2006. This legislation was the result of government studies that showed
Medicaid payments for generic drugs were significantly higher than the prices pharmacies paid wholesalers.
The legislation targeted pricing by switching the mechanism for setting drug reimbursement levels from one
based on average wholesale prices (AWP) to one based on average manufacturer prices (AMP).
Reduced reimbursement levels would have caused many community pharmacies to reduce or discontinue
their participation in Medicaid; some pharmacies that rely on a high percentage of Medicaid customers
could have gone out of business. The new healthcare law changes the provision in the Deficit Reduction Act
of 2005 that pertained to the definition of, and method for calculating, the AMP. This provides an improved
approximation of the costs to pharmacies for purchasing generic drugs.
An economic impact study of the Deficit Reduction Act of 2005 found that 11,105 pharmacies across the US
could have closed due to reductions in the Medicaid reimbursement rate, which is well below their cost to fill
prescriptions, according to a report released by the National Association of Chain Drug Stores and the Food
Marketing Institute. The largest reductions in the number of pharmacies were projected to be in New York
(40%), the District of Columbia (37%), Louisiana (32%), West Virginia (30%), and Alaska (28%).
TENSIONS ESCALATE BETWEEN LARGEST DRUGSTORE OPERATORS
On June 7, 2010, Walgreen announced its withdrawal from participation as a provider in any new and
renewed prescription drug plans awarded to CVS Caremark Corp.s pharmacy benefit manager (PBM).
With $4.5 billion pharmacy dollars annually generated from participation in CVS Caremarks prescription
drug plans, Walgreen put more than 7.5% of its business at risk with the notification. Walgreen and CVS
are the nations two largest drugstore operators in terms of both number of stores operated and total sales.
Walgreen believed it was no longer in the best interests of its customers, pharmacists, and shareholders to
grow its future business with CVS Caremark. Walgreen highlighted the following three points of contention
in a letter it sent to CVS.
! Walgreen believed CVS Caremarks promotion of prescription drug plan designs (such as
Maintenance Choice) disrupted networks by requiring patients with chronic conditions in many plans
to use CVS pharmacies or Caremark mail service facilities for their prescriptions instead of using
Walgreens drugstores. Walgreen believed this limited patient choice and ended up separating patients
from the Walgreens pharmacists they knew.
! Walgreen received no or little information when a CVS Caremark prescription drug plan was
transferred to a different and differently-priced CVS Caremark pharmacy network, or when CVS
Caremark acquired a new prescription drug plan as a client. This made it difficult for Walgreen to
assess and decide in advance whether to participate in new and altered CVS plans.
! Walgreen believed CVS Caremark drug reimbursement rates were growing unpredictable.
Additionally, it believed CVS Caremarks payments for certain drugs often did not reflect the market
rate, making it difficult for Walgreen to plan for and operate its business.
CVS Caremark strikes back
Walgreen did not intend for its withdrawal from future participation in CVS Caremark prescription drug
plans to affect current CVS Caremark plans in which Walgreen was already a pharmacy provider. However,
in reaction to the Walgreen announcement, CVS Caremark announced that it would terminate Walgreens
participation in its retail pharmacy networks on July 9, or as otherwise required by applicable law or
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contract requirements. Additionally, CVS Caremark terminated Walgreens participation in its Medicare
Part D retail pharmacy networks effective January 1, 2011.
Success of CVS Caremarks operating model questionable
Following the loss of about $4 billion of pharmacy benefit management (PBM) business to competitors
during 2009, scrutiny of CVS Caremark Corp.s combination PBM and retail drugstore model was raised as
the company anticipated a significant decline in PBM sales for 2010. The large amount of lost business
raised doubts about the advantages of a combination PBM and retail drugstore model. Skeptics pointed out
potential customer concerns regarding possible conflicts of interest between a PBM, responsible for reducing
client costs, and a retail drugstore operator, whose goal is to maximize volumes and margins. The company
was quick to respond that although the combined PBM/drugstore model lost significant business in 2009,
the model actually gained market share (based on the number of clients) and won as much business from
competitors (based on dollars) as it lost since CVS acquired Caremark RX in March 2007.
The combination of CVS and Caremark generated more than $700 million in savings from economies of
scale, such as significant purchasing savings and overhead cost reductions. The company is the largest
purchaser of prescription drugs in the world. In the long term, CVS Caremark Corp. hopes the combined
model will allow it to win new business by improving access to healthcare and offering greater convenience
through the combination of its mail order and retail businesses.
CVS believes its offerings are unmatched in the retail drugstore and pharmacy benefit management
industries. The company implemented its Proactive Pharmacy Care program in 2008 to increase customers
prescription drug adherence. The program helps identify and notify customers of drug opportunities, such
as new prescriptions, lower-cost generic alternatives, and missed prescriptions. As part of this program, the
company launched Maintenance Choice, which allows customers to buy 90-day prescriptions at retail
outlets for the same price as through the mail. As of February 2010, 482 of CVSs clients, representing 5.5
million lives, have adopted Maintenance Choice or will adopt it in 2010. With more than double the
number of clients signing up for the new program since the start of the 2009, the program appears to be
gaining acceptance.
The company is pointing to the marketing of the new product offerings as a significant factor in the
disappointing demand for its products in 2010. Following the merger of CVS and Caremark in 2007, the
company began developing new products. The company started selling these new products to clients in
2008 and began experiencing slowing demand for its products in 2009. While competitors sales personnel
were focusing on their service offerings and their ability to save customers moneycore PBM objectives
CVS Caremarks highlighted the retail drugstore benefits customers would experience. By not focusing on
the core PBM offerings clients sought, the company believed it was poorly positioned to retain and win new
customers. PBM clients needs include improving generic dispensing rates, increasing usage of generic drugs,
managing drug utilization, and improving the health of the population. In an effort to improve its PBMs
performance, the company announced the retirement of Howard McLure, the president of Caremark
(effective November 27,

2009) and the hiring of a new senior VP of marketing for its PBM. In December
2009, the company announced the appointment of Per G.H. Lofberg as president of its PBM business,
effective January 4, 2010.
The potential impact on each side
Due to CVS Caremarks disappointing performance in 2009 and the recent success of its Maintenance
Choice program, Walgreens actions were an act of defiance against a strengthening retail drugstore
competitor. A permanent withdrawal by Walgreen from CVS Caremarks business would negatively impact
CVS Caremarks ability to sign new drug plan clients that are seeking convenient access to prescription
drugs for their members. Such a scenario could potentially lead to a further weakening of the combined
PBM/drugstore model at CVS Caremark.
However, Walgreen also put a significant portion of its business at stake. With not only $4.5 billion in
pharmacy sales at risk, but also the more profitable non-pharmacy sales that accompany those transactions,
a permanent withdrawal from CVS Caremarks plans would have a significantly negative impact on its sales
and profitability. Additionally, CVS Caremark states that when Walgreens drugstores are included in its
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pharmacy network, 85.9% of plan members on a national basis have access to a network pharmacy within
a 3-mile radius of where they live. When they are excluded, that number changes negligibly to 85.7%. This
suggests that CVS Caremark is confident in its position that it would be able to withstand a long-term
withdrawal of Walgreen without sustaining a significant impact on its overall business. While the statistics
on national coverage may be slightly misleading, as Walgreens significant market share advantages in some
markets would almost certainly have a negative impact on CVS Caremarks ability to sign PBM clients, it
does show CVS Caremarks confidence in not backing down to Walgreens demands.
The two sides reach an agreement
The companies quickly reached an agreement on June 18, 2010. However, financial terms were not
disclosed. Walgreens actions were likely a negotiating tactic to try to raise the pharmacy reimbursement
rates it received from CVS Caremark. Walgreen has used its size and market share to its advantage in the
past to squeeze out more favorable drug reimbursement rates during Medicaid negotiations with states. For
its part, CVS Caremark would only lose from a prolonged standoff as it is in the midst of negotiating
contracts that begin in the 2011 calendar year.
Walgreen acquires Duane Reade
Walgreen strengthened its retail drugstore footprint in April 2010 with the acquisition of Duane Reade for
$1.1 billion in cash. Duane Reade is the market share leader in the New York metropolitan area, the largest
US retail drug market. Scale benefits include improved sales leverage due to the elimination of overhead
costs and improved acquisition leverage.
Walgreen also stands to benefit from the sharing of best practice techniques, combining Duane Reades
expertise in non-pharmacy merchandising and the companys knowledge of pharmacy sales. Walgreen plans
to increase its offerings of consumables in 2010, and will look to Duane Reade to help it execute its strategy.
Walgreen is likely to keep the Duane Reade banner name in place, at least in the intermediate term. With a
strong retail banner, Duane Reade has strong brand awareness in the New York City market. Walgreen
risks alienating Duane Reades customers by changing its name too soon.
INDUSTRY OUTLOOKS
Positive outlook for drugstores
Standard & Poors believes that chain drugstores are well positioned to benefit from continued growth in
demand for prescriptions due to an aging US population, increased long-term utilization of generic drugs,
and improved inventory management practices. Demand for pharmacy services and products is growing due
to the aging of the baby boom generation. The use of prescription pharmaceuticals increases significantly as
people agefrom fewer than five prescriptions per year for those under age 44, to 12.5 per year at age 60,
and 20.0 per year at age 70. We believe that
demand will continue to improve, as the
boomer generation, which represents more
than 25% of the US population, began
turning 60 in 2006.
Drugstores are well positioned to benefit from
healthcare reform in the US, as an increase in
insurance coverage will lead to increased
prescription drug utilization, a rise in demand
for pharmacist services, and greater demand for
convenient prescription drug access. Drugstores
are optimally positioned with 24-hour stores,
drive-through service, and convenient parking
located close to consumers homes.
Pharmacies are also benefiting from increased
sales of generic drugs. Although generic drugs
Chart H03:
FOOD &
DRUGSTORE
PROFIT
MARGINS
FOOD & DRUGSTORE PROFIT MARGINS
(In percent)
(1.0)
(0.5)
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
1996 97 98 99 00 01 02 03 04 05 06 07 08 2009
Food retailj Drug retailj
jS&P 1500 subindustries.
Source: Standard & Poor' s.
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are priced at about a 75% discount to brand name drugs, they are more profitable. Generics generate higher
gross profit dollars, on average, and carry gross margins of at least 50% (versus branded gross margins of
up to 15%). As drugs lose patent protection in the coming years, significant margin benefits for chain
drugstores can be expected.
Food retailers outlook improving
Deflationary food prices and increased consumer pricing sensitivity pressured sales and earnings in the first
half of 2010. However, with inflation expected to return in the second half of the year, a reduction in
unemployment levels, and easier comparisons, we believe sales and earnings trends will improve into 2011.
Although consumers remain price-conscious, recent activity suggests consumers are beginning to trade back
up to higher-priced product alternatives (for example, demand for higher-priced wines is increasing), to
branded products from lower-priced private label, and into higher-priced formats (away from discounters
and toward specialty retailers such as natural food formats). Nevertheless, we expect intense pricing
competition to only modestly weaken as discounters increase promotional and marketing spending in an
effort to maximize retention of new customers gained during the economic downturn over the past few
years. For example, Wal-Mart Stores Inc. announced a plan in May 2010 to reduce prices on a number of
high-profile foods (where price comparison is easier). Meanwhile, traditional food retailers are re-
emphasizing their convenient locations, and improved prepared food offerings.
Standard & Poors thinks that retail food industry sales trends will benefit from increased food inflation in the
second half of 2010 and an improved economic environment, despite ongoing price-cutting from discounters
in an effort to maintain traffic in stores. We look for profit margins to widen as acceleration in sales growth
leads to improved sales leverage. We believe risks remain high, however, as the return of food inflation does
not guarantee a sales and margin benefit. Higher shelf prices may cause price sensitive consumers to trade
down to discounters, and may pressure margins if retailers delay passing along the higher food costs in fear of
losing consumers. We believe that struggling chains could continue to benefit by divesting underperforming
non-core assets and focusing investment resources on markets they already dominate. Taking everything into
account, our fundamental outlook for the food retail industry was neutral as of early July 2010.
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INDUSTRY PROFILE
Survival of the fittest: supermarkets and drugstores do battle
Competition among supermarket and drugstore operators has intensified in recent years, partly reflecting
the industries maturity and rapid consolidation. Today, it is not uncommon to find competing drugstores
or supermarkets within a mile or two of each other. In addition to competition with each other, both
industries face competition from supercenters, warehouse clubs, and other kinds of retailers.
SUPERMARKETS
With sales totaling $1.021 trillion in 2009, the US grocery store industry includes a range of businesses,
from small grocery shops and convenience stores to large supermarket chains. (The Standard & Poors
definition of the industry excludes restaurants and department stores that sell gourmet foods.) Progressive
Grocer, a monthly industry
publication, reports that
approximately 35,612
supermarkets operated in the
United States in 2009. These
outlets accounted for 16.7% of
grocery store units and 54.5% of
food item sales by grocery stores.
The category includes supercenters
and warehouse outlets. Other
formats include convenience stores
(with 144,108 units, accounting for
67.4% of all grocery store units
and 31.9% of sales), and wholesale
clubs (1,207 units, accounting for
0.6% of stores but 11.5% of sales).
Other smaller categories account
for the balance.
Chain supermarkets generated sales
of $527.8 billion, or 94.8% of total
supermarket sales, compared with
$29.2 billion (5.2%) by
independents. In 2009, some
29,312 (82%) of the nations
supermarkets were affiliated with a
chain, while 6,300 supermarkets
(the remaining 18%) operated
independently, according to
Progressive Grocer. Total sales
growth for supermarkets
decelerated in 2009 to 1.8% from
2.2% in 2008 and 7.2% in 2007.
Within the supermarket category,
average sales per store increased
1.2% to $15.6 million ($557.0
million from 35,612 stores) from
$15.5 million ($547.1 million from
35,394 stores). Excluding inflation
Table B01:
GROCERY
STORE SALES
GROCERY STORE SALES-2009
(By size and ownership)
NUMBER % OF SALES % OF
OF STORES TOTAL (BL. $) TOTAL
ALL SUPERMARKETS (over $2.0 million) 35,612 100.0 557.0 100.0
Chain supermarkets 29,312 82.3 527.8 94.8
$2 million-$3.9 million 2,702 7.6 7.7 1.4
$4 million-$7.9 million 6,677 18.7 34.9 6.3
$8 million-$11.9 million 3,551 10.0 33.3 6.0
$12 million-$19.9 million 5,004 14.1 72.9 13.1
$20 million-$29.9 million 5,332 15.0 118.6 21.3
$30 million-$39.9 million 2,401 6.7 74.8 13.4
$40 million-$49.9 million 1,428 4.0 57.2 10.3
$50 million and over 2,217 6.2 128.3 23.0
ndependent supermarketsj 6,300 17.7 29.2 5.2
$2 million-$3.9 million 2,190 6.1 6.0 1.1
$4 million-$7.9 million 3,609 10.1 17.5 3.1
$8 million-$11.9 million 350 1.0 3.1 0.6
$12 million-$19.9 million 121 0.3 1.7 0.3
$20 million-$29.9 million 23 0.1 0.5 0.1
$30 million-$39.9 million 3 0.0 0.1 0.0
$40 million-$49.9 million 3 0.0 0.1 0.0
$50 million and over 1 0.0 0.1 0.0
Supermarkets, by format, total 45,612 100.0 557.0 100.0
Conventional 36,725 80.5 361.9 65.0
Superstore combo (30,000 sq.ft. min.) 3,403 7.5 154.5 27.7
Limited assortment (under 1,500 items) 2,601 5.7 12.0 2.2
Natural/gourmet foods 2,242 4.9 20.9 3.8
Warehouse (low price/service) 465 1.0 3.4 0.6
Military commissary 176 0.4 4.2 0.8
Other food formats, total* 178,169 100.0 464.2 100.0
Convenience** 144,108 80.9 325.8 70.2
Gas station/kiosk 19,465 10.9 NA NA
Superette 12,956 7.3 18.7 4.0
Wholesale club stores 1,207 0.7 117.3 25.3
Military 433 0.2 2.5 0.5
TOTAL GROCERY STORES 213,781 . 1,021.2 .
jDefined as 10 or fewer stores under one management. *Supermarket items only.
**Excluding gas. NA-Not available.
Source: Progressive Grocer's Annual Report of the Grocery Industry.
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of 0.5% for food-at-home offerings, according to the Bureau of Labor Statistics, average sales per store
increased only 0.7% in 2009 as an unfavorable economic environment resulted in consumers trading down
to lower-priced goods within supermarkets.
The supermarket industry remains one of the most
fragmented US retail sectors. In 2009, the top 10 food
retailers accounted for just 36.9% of total food
industry sales. One of the fastest-growing
supermarket formats, in terms of sales per store, is the
natural/gourmet foods format. According to
Progressive Grocer, there were 2,242 natural/gourmet
stores with total grocery item sales of $20.9 billion in
2009. The natural/gourmet store count increased
3.0% that year, and average sales per store rose 2.6%
to $9.3 million.
DRUGSTORES
At the end of 2009, there were 44,412 chain and
independent drugstores in the United States, down
0.6% from 44,140 a year earlier, according to the
National Association of Chain Drug Stores. Of this
total, 24,560 (55.3%) belonged to chains, and 19,852
(44.7%) were independent.
Prescription sales for all chain and independent
drugstores in 2009 totaled $142.8 billion, up 4.5%
from $136.6 billion in 2008, according to IMS
Health, a healthcare information company. Chain
drugstores generated $105.5 billion in prescription
sales, up 5.8% from $99.7 billion in 2008. Chains
accounted for 35% of US prescription sales in 2009.
The top three drugstore chains in 2009Walgreen
Co., CVS Caremark Corp., and Rite Aid Corp.had
approximately $44.4 billion in total retail sales
(including non-pharmacy items, but excluding
Walgreens acquisition of Duane Reade in April
B08: TOP 10
SUPERMARKET
CHAINS
TOP 10 SUPERMARKET CHAINS-2009
(Ranked by sales)
SALES NO. OF SQ.FT. SELLNG
CHAN (ML. $) STORES AREA (THOUS.) TOP BANNER NAMES
1. Wal-Mart* 154,249 2,906 179,999 Wal-Mart Supercenter, Wal-Mart Neighborhood Market
2. Kroger 62,608 2,470 105,777 Kroger, Ralphs Grocery, Fred Meyer
3. Safeway 35,022 1,486 54,399 Safeway, Vons Market, Dominick's
4. SuperValu 31,461 1,516 51,921 Albertsons/Supervalu, Save A Lot, Shaw's
5. Ahold USA 24,102 708 29,772 Stop & Shop, Giant-Landover, Giant-Carlisle
6. Publix 21,645 1,012 37,353 Publix, Publix Sabor, Publix GreenWise
7. Delhaize America 18,788 1,604 47,760 Food Lion, Hannaford Food & Drug, Sweetbay Supermarket
8. H.E. Butt Grocery 11,642 280 13,997 H.E. Butt Food Store, H.E. Butt Plus, H.E. Butt Central Marke
9. Great Atl. & Pac. Tea Co 9,181 408 13,619 Pathmark, A&P, Super Fresh
10. Meijer 8,624 191 12,289 Meijer
*Estimated data for supermarket items only.
Source: Progressive Grocer.
Table B10: US
PRESCRIPTION
MARKET, BY
DISTRIBUTION
CHANNEL
US PRESCRIPTION MARKET, BY DISTRIBUTION CHANNEL
(Ranked by 2009 sales)
SALES MARKET
----- (BL. $) ----- --- SHARE (%) ---
2008 2009 2008 2009
Chain stores 99.7 105.5 34.9 35.1
Mail service 46.5 51.5 16.3 17.1
ndependent stores 36.9 37.3 12.9 12.4
Clinics 33.0 34.6 11.6 11.5
Non-federal hospitals 26.9 27.8 9.4 9.3
Food stores 20.4 21.2 7.1 7.1
Long-term care 13.7 13.9 4.8 4.6
Federal facilities 3.8 4.1 1.3 1.4
Home health care 2.5 2.5 0.9 0.8
HMOs 1.3 1.1 0.5 0.4
Miscellaneous 0.9 1.0 0.3 0.3
TOTAL 285.7 300.3 100.0 100.0
Source: MS Health nc.
Table B07: TOP 10
US DRUG
CHAINS
TOP 10 US DRUG CHAINS-2009
(Ranked by sales)
SALES NUMBER
CHAN (ML.$) OF STORES
1. Walgreen 63,340 7,180
2. CVS 55,360 7,027
3. Rite Aid 25,670 4,781
4. Health Mart 6,200 2,555
5. Medicine Shoppe nternational 2,100 708
6. Duane Reade* 1,840 258
7. Marc Glassman 1,230 61
8. USA Drug 1,050 161
9. Kinney Drugs 743 94
10. Kerr Drug 629 90
*Acquired by Walgreen in April 2010
Source: Chain Drug Review.
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2010), accounting for about 42% of total retail chain drugstore market share and 31% of total retail
drugstore market share (but only 15% of US prescription sales), according to data from IMS Health. These
three chains operated approximately 18,990 stores, accounting for about 42.8% of total drugstore units,
according to Chain Drug Review.
INDUSTRY TRENDS
Supermarket operators are looking to become more innovative in their product offerings to differentiate
their stores and gain a competitive edge. These retailers hope to increase their value-added product offerings
and, therefore, avoid head-to-head competition with large discount operators, such as Wal-Mart Stores,
Inc., which focus on selling commodity goods. Supermarkets in recent years have shifted their focus toward
diversified product offerings by adding organic, ethnic, and natural food sections to their stores.
An aging US population, increased usage of generic drugs, and greater access to healthcare provide a
favorable long-term environment for the drugstore industry, in our view. Drugstore operators look to drive
sales growth and increase traffic to their stores by improving service offerings, increasing the convenience of
stores, and enhancing the shopping experience through better merchandising.
SUPERCENTERS: DOMINATING MARKET SHARE
Supercenters are huge retail outlets (more than 150,000 square feet, on average) that house a mass
merchandiser and a combination food and drugstore in a single unit, and devote as much as 40% of their
shelf space to grocery items. They continue to enjoy strong sales growth.
Sales of supermarket items at supercenters totaled $154.5 billion in 2009. Supercenters now hold a 27.7%
market share of the supermarket category. Although their profit margins on grocery items are not high,
supercenters generate heavy store traffic by virtue of their size, resulting in greater sales of general
merchandise, which has higher margins. Wal-Mart Stores Inc. is the major player in this arena, accounting
for a majority of supercenter industry sales, followed by Target Corp. and Kmart Corp. (part of Sears
Holding Corp.).
Wal-Mart continuing to grab market share
With grocery sales in 2009 estimated at about $155 billion from its Walmart Supercenter, Discount Store,
and Neighborhood Market formats, Wal-Mart is the largest seller of supermarket goods in the United
States. The Kroger Co. ($62.6 billion) and Safeway Inc. ($35.0 billion) are second and third largest,
respectively. Walmart Supercenters constitute the biggest threat to the traditional chain food and drug retail
industries. Standard & Poors estimates that supermarket merchandise accounted for over 50% of Walmart
Supercenter sales in 2009.
Much of Wal-Marts success in gaining market share in food retailing centered on its everyday low price
strategy and significant expansion of square footage. While the company remains committed to remaining
price competitive, it plans to slow US square footage growth from its historical rate of 8% annually as it
redirects its capital spending programs toward its faster-growing international markets. In fiscal 2011,
although the company intends to add 12 million square feet of retail space in the US, it plans to increase
focus on remodeling stores rather than opening new locations. Standard & Poors believes this new focus
will result in improved comparable store sales performance as the negative impact from new store sales
cannibalization is reduced.
Wal-Mart considers itself a food distributor, not a food retailer. Its strategy is to make its products available
to customers at the lowest possible cost. By leveraging its size with food manufacturers, keeping employee
costs down, and investing in modern and more efficient technology, the company has become the industrys
price leader.
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CATERING TO NEW TASTES
In order to better compete against low-price operators, supermarkets are differentiating their product
offerings by responding to consumer interests. According to the Food Marketing Institute, a nonprofit
organization that provides research, education, and public relations services to its members, most stores
now offer prepared foods for take-out (94% of stores) and floral departments (86%) in order to meet
customer needs. Other niche markets that are attracting supermarket operators include ethnic foods (89%)
and organic and natural foods (57%).
Ethnic focus
The composition of the US population is changing rapidly. In the 1990s, the number of Hispanics and
Asians grew four times as fast as the population as a whole, while the African American population
expanded about 20% faster. Overall, the minority population in the US reached 104.6 million in 2008, or
34% of the total population. In 2009, four states had more than 50% of their population made up of
people other than single-race non-Hispanic whites: Hawaii, New Mexico, California, and Texas. Nevada,
Maryland, Georgia, Arizona, New York, and Mississippi all contained white majorities of less than 60% of
their populations. Given this growth, Standard & Poors expects supermarkets to continue focusing on this
expanding segment.
Among consumers of ethnic food, the Hispanic population is the largest minority population in the United
States. The nations Hispanic population represented about 15% of the total US population in 2008. The
groups purchasing power is expected to reach $1.2 trillion by 2010, according to the Selig Center for
Economic Growth. This segments population growth rate (25% since 2000) was much faster than the
growth rate of the overall US population during that time. The US Census Bureau projects that Hispanics
will make up 17% of the US population by 2025 and 23% by 2050.
Wal-Mart is testing Hispanic formats at stores in Houston and Phoenix, which opened in April and June
2009, respectively. The new stores offer products that appeal specifically to this group (fresh tortillas and
corn chips, Hispanic-oriented fresh fruits and vegetables, and ice cream and juices popular among Latinos).
The 39,000-square-foot stores are called Supermercado de Walmart and are located in former
Neighborhood Market stores.
Wal-Mart also opened its first new club store format targeting Hispanics in Houston in August 2009. The
new store is called Mas Club and carries products from Mexico. Supermarket chains with units located in
heavily Hispanic areas are also targeting these customers by hiring bilingual cashiers and stockers, and
featuring whole aisles devoted to regional foods.
Organic and natural foods grow in popularity
Expansion of natural and organic food offerings is a major opportunity for supermarkets to differentiate
themselves from price-based competitors. The organic food category generated an estimated $24.8 billion in
sales in 2009, up 5.1% from about $23.5 billion in 2008, according to the Organic Trade Association, an
industry group. With nearly 40% of consumers purchasing items labeled organic, most consumers who
buy natural and organic products are doing so in their primary supermarket. Standard & Poors expects
supermarkets to pay increasing attention to this category, where sales increased at a compound annual
growth rate of about 18% from 1998 to 2008.
Stores that specialize in natural and organic foods should continue to experience growth, despite an adverse
economic environment. Standard & Poors projects that Whole Foods Market Inc., the largest organic and
natural food chain in the US, will grow sales 11%, to $9.9 billion, in its fiscal year ending September 2011,
from an estimated $8.9 billion in fiscal 2010.
Because of growing customer interest in natural and organic foods, retailers not only are increasing square
footage within stores devoted to this category, but also are testing plans to open natural and organic food
stores. Safeway, for example, has increased square footage in its newly reformatted stores in response to
strong demand for natural and organic products.
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PRIVATE LABELS PROMOTE LOYALTY
As supermarkets and drugstores become more competitive, they are increasingly developing and promoting
private-label brands to differentiate themselves from their competitors. These goods are produced by
manufacturers under contract to a retailer, which distributes them exclusively under its own label. Also known
as house brands, private-label products let a supermarket or drugstore offer its customers products that can be
found only in its stores. According to the Private Label Manufacturers Association, an international trade
association, sales of private-label goods generated 28.7% of all unit sales and 23.7% of all dollar sales in
supermarkets in 2009. Over the past five years, private-label sales have grown 34% to $55.5 billion in 2009.
In drugstores, private-label sales have increased 45% over the past five years to $6.1 billion. In drugstores,
14.1% of all dollar sales and 16.7% of all unit sales were from private-label goods.
Private-label goods can improve a stores image and promote customer loyalty, but they make business
sense as well. For consumers, they offer a 10% to 40% price advantage over national brands. At the same
time, they can give retailers margins of 35% to 40%, compared with an average of 27% on national
brands.
Once regarded as generic and low quality, private-label brands have improved their image over the past
decade, which has helped them gain acceptance. Standard & Poors believes that sales of private-label
products by supermarket and drugstore chains will continue to grow, as new products and new product
categories are added and as customers realize the high quality these products offer. In addition, ongoing
consolidation in the supermarket and drugstore industries should help growing regional chains develop
better-recognized store-brand labels.
BRIGHT LONG-TERM PROSPECTS FOR DRUGSTORES
The drugstore industry is expected to benefit from favorable long-term trends that include an aging
population, a strong drug pipeline, and expanded healthcare coverage for Medicare participants. By 2019,
prescription drug spending is expected to reach $457.8 billion, growing at a compound annual growth rate
(CAGR) of 6.5% from a projected $260.1 billion in 2010, according to the Centers for Medicare &
Medicaid Services (CMS), the federal agency that administers Medicare, Medicaid, and the state Childrens
Health Insurance Program (CHIP).
In this century, the US will see a steep rise in the number
of elderly residents. The Census Bureau reports that
about 72 million people in the United Statesabout one
of every five peoplewill be 65 or older by 2030.
Pharmacies are currently experiencing an increase in
demand from this aging US population.
This expected growth is particularly important for anticipating healthcare and assistance needs. The elderly
represented about 13% of the total population (40.2 million people were over 65 in 2009), but they
accounted for an estimated one-third of all prescriptions written. The average annual number of
prescriptions per person increases significantly with age, from 5.6 prescriptions for those aged 15 to 44, to
18.7 prescriptions for 45- to 64-year-olds, to 28.6 prescriptions for people aged 64 and older. The baby
boomersthe approximately 77 million Americans born between 1946 and 1964are getting older (the
first boomers turned 60 in 2006), so increased drug utilization is benefiting drugstores.
Among other trends that should aid drugstore sales, new drugs are entering the market every year, and the
average price for new drugs continues to rise. New and more effective drug therapies, some coming from
biotechnology research, will be key drivers of US drug sales growth.
Drug price inflation also will benefit drugstore sales. The average prescription price was $71.69 in 2008
(latest available), up 4.2% from $68.77 in 2007. Drug price inflation was higher than the overall rate of
inflation of 3.8% for the year, though average drug prices were hurt by a shift in the mix of branded drugs
and generic drugs. The average price of a brand name prescription increased 13.8% to $137.90 in 2008,
"#$%&!
'()*!
PROJECTED GROWTH IN US SENIOR POPULATION
2010 2030 % CHG.
Total population (mil.) 310.2 373.5 20
65-and-over population (mil.) 40.2 72.1 79
65-and-over as % of total 13.0 19.3 ..
Source: US Census Bureau.
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while the average generic drug price rose 9.4% to $35.22. Greater usage of lower-priced generics in 2008
partially offset some of the increase due to inflation.
Generic drugs should benefit margins
After struggling with the gross margin erosion in the 1990s that accompanied the rise of managed care, the
drugstore industry may be poised to recapture some of that lost ground with the help of generic
pharmaceuticals. (A generic is a drug sold under its chemical name after the brand name drugs patent
expires.) Generics accounted for 75% of all prescriptions filled in 2009, according to IMS Health, a
pharmaceutical market research firm.
Because generics yield higher gross margins for pharmacies than name-brand drugs do, most drug chains are
likely to profit from the trend to generics. Key factors spurring this growth include the expanded influence of
managed care, an exceptionally large number of branded drugs losing patent protection in recent and coming
years, and the implementation of new Medicare outpatient prescription drug coverage in January 2006.
Given that the average price for a generic drug prescription was $35.22 in 2008 (latest available), versus an
average of $137.90 for branded drugs, these changes will yield substantial savings for healthcare plans and
consumers. According to the US Food and Drug Administration (FDA), drug costs per day can fall by 15%
16% if patients use generics instead of branded drugs, depending on their medical needs. Patients whose needs
can be fully satisfied with generics could enjoy reductions of 52% in the daily costs of their medications. Thus,
Standard & Poors expects healthcare plans to encourage drug chains to continue to promote generic drugs.
It seems counterintuitive that drugstores would benefit from a development that reduces their top line, but
chains say that is, in fact, the case. Generic drugs yield wider margins, both on a percentage basis and in
actual dollars, than branded drugs, and they reduce inventory investment.
Mail-order business gaining momentum
Mail-order pharmacies are the fastest-growing format in the drugstore industry. These pharmacies primarily
dispense prescriptions for medications used on a continuing basis for long-term illnesses or chronic
conditions.
Health plan designs often allow mail-order pharmacies to offer customers a 90-day supply of drugs, instead
of the usual 30- or 60-day supply. Customers save money, as they pay only one copayment for a 90-day
supply instead of three copayments (to purchase three 30-day supplies) at a retail drugstore. Prescriptions
are typically filled and mailed to customers within three to five days, but they can be delivered overnight for
a fee. Mail-order pharmacies offset the additional costs of mailing medications with the efficiencies of
handling bulk medications and the lack of overhead expenses associated with running a retail outlet.
In addition to saving customers money due to fewer copayments, mail-order pharmacies compete with retail
drugstores on convenience. Mail-order pharmacists are typically available to offer counseling 24 hours a
day through a toll-free telephone number.
Almost all pharmacy benefit managers (PBMs) offer mail-order services. In terms of consumers served, the
three largest PBMs in the US are CVS Caremark, MedcoHealth Solutions Inc., and Express Scripts Inc.
PBMs help their clients (public or private sponsors of health benefit plans) contain drug expenses in claims
administration, pharmacy network management, negotiation and administration of product discounts, and
mail-order service. In addition, PBMs improve clients prescription drug benefits through formulary
development (i.e., creating a list of prescription drugs approved for coverage under a clients benefit plan)
and consultation on the design of the prescription drug benefit of a clients health plan.
Drugstores differentiate with greater convenience, exclusive goods
Drugstores are trying to increase convenience for consumers and build customer loyalty by operating 24-
hour stores, building freestanding stores with drive-through pharmacies, and investing in automated
prescription-fill technology to free pharmacists time. Drugstores also are focusing on merchandising to
differentiate themselves from competitors.
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To maximize sales and drive store traffic, drugstore operators continue to relocate to stand-alone locations
and are increasingly keeping stores open 24 hours. They believe that expanded service hours eventually will
provide a return on investment through increased sales and improved customer loyalty, though initially
these efforts tend to result in narrower margins, due to additional labor expenses. Other efforts to improve
customer loyalty include adding drive-through pharmacies and offering one-hour photo service. Walgreen
Co. has made considerable progress in these efforts, with a majority of its stores freestanding, providing
one-hour photo service, and offering drive-through pharmacy service.
To compete more effectively against retailers that offer lower prices, drugstore operators are seeking
products not offered by others. CVS, for example, exclusively sells Playskool brand toys and Skin Effects
beauty aids. CVS-branded and exclusive product offerings made up about 17% of the companys total
front-end sales in the first quarter of 2010. CVS added over 900 new private-label products in 2009 and
plans to add over 1,100 new products in 2010.
In-store health clinics provide edge
To better meet consumer needs while further differentiating their offerings, drugstore operators have added
in-store health clinics to their stores in recent years. Services focus on the diagnosis of minor medical
conditions such as coughs and colds, ear infections, strep throat, bronchitis, and sinus infections (patients
with conditions that are more complex or serious are referred to physicians). These clinics better positioned
drugstores to meet increased consumer demand. As of June 2010, about 1,200 health clinics within
drugstores were in operation in 32 states.
The largest provider of retail-based health clinics in the US is MinuteClinic, acquired by CVS Caremark in
2006. As of February 2010, there were 570 MinuteClinics in operation (including 100 seasonal clinics) in
56 markets in CVS stores, and the company had treated more than 6.2 million patients since inception. The
clinics experienced 50% year-over-year growth in acute sick visits (excluding flu shots) from September
through December 2009. In 2010, the company will focus on adding monitoring services for common,
chronic illnesses, such as hypertension and high cholesterol.
While 80% of MinuteClinic site visits are by customers covered by health insurance, convenient care clinics
can also help drugstores target the 30% of the US population that does not have a primary care physician or
the time to visit one. Customers are attracted to clinics because waiting times and out-of-pocket costs are
often less than emergency room visits or doctors offices.
While the growth in the number of retail clinics will likely grow 10% to 15% between 2010 and 2012,
growth is expected to accelerate to above 30% from 2013 to 2014, according to Retail Clinics: Update and
Implications, a report by Deloitte Center for Health Solutions. The report cites an increase in consumer
spending with recovery of the macroeconomy, increased participation and encouragement by health plans,
increased consumer awareness and acceptance, and increased investment in preventive health services due to
healthcare reform.
HOW THE INDUSTRY OPERATES
Food retailing and drug retailing were once intensely personalized businesses. Farmers or neighborhood
shop owners sold food, while a family doctor or neighborhood pharmacist sold pharmaceuticals. Owners of
the early mom-and-pop stores often lived in the same neighborhood where their businesses were located, so
they could get to know a lot about their customers: their names and ages, where they lived and worked,
about how much they earned, the size of their households, and their likes and dislikes.
In the mid-twentieth century, people began migrating from cities to suburbs in large numbers. Merchants
followed them, leading to explosive growth in shopping centers and, eventually, to the formation of giant
chains. Large supermarket and drugstore chains came to dominate the retail landscape, which complicated
sales practices. Often far removed from their customers, retailers had to spend considerable time and money
to obtain information that earlier generations of shopkeepers came by firsthand.
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Today, retail chains act as intermediaries that bring producers and consumers together. They purchase
products from a large number of suppliers, in wide enough assortments to satisfy their customers; they
move those products to a retail store, where customers may choose among them; they maintain the
products freshness; and they complete the sales by checking out and bagging merchandise at a cash register.
Store hours are often long, to suit the varying schedules of a complex society.
Given that supermarkets and drug chains typically sell staple products, their business is generally
noncyclical. Regardless of how the economy is doing, people need to eat and to use pharmaceuticals and
over-the-counter drugs. Thus, while sales at drug and supermarket chains may be somewhat affected by a
slumping economy, they are more resilient than those at most retailers.
MAIN CATEGORIES
Supermarkets and chain drugstores are the dominant retail outlets for food and drug sales today. Below, we
outline the typical store formats. Other formats exist, but they are largely variations of drugstores and
supermarkets.
Supermarkets
A supermarket is a retail business that typically has more than 5,000 square feet of selling space (of which
at least half is dedicated to grocery items) and annual sales of more than $2 million. Standard formats
include conventional and price impact supermarkets, superstores, combo stores, and supercenters.
Traditional supermarkets. A conventional supermarket is a full-line, self-service retail store that sells dry
groceries, canned goods, nonfood products, and perishable goods. To distinguish it from a grocery store, a
supermarket is generally classified as having annual sales of $2 million or more. Stores typically carry
between 15,000 and 60,000 stock keeping units (SKUs), according
to the Food Marketing Institute (FMI).
Superstores. A superstore (not to be confused with a supercenter)
is essentially a supersized supermarket, with floor space of about
30,000 square feet (around twice the size of a traditional
supermarket). Annual sales average some $12 million or more,
according to FMI. About 10% to 20% of a superstores selling
space is devoted to nonfood items, specialty departments (such as
florists), and services (such as in-store banking or video rentals).
Expanded offerings of nonfood items and larger size differentiate
superstores from supermarkets. Some superstores (but not all) have
small pharmacies. The Stop & Shop Supermarket Co., for example,
operates superstores under the Super Stop & Shop name.
Combination (combo) stores. This format unites the features of a
superstore and a full-line drugstore with a common checkout area. Combo stores are significantly larger
(floor space averages about 55,000 square feet) and offer many more items (about 50,000 SKUs) than either
superstores or traditional supermarkets, typically devoting 33% or more of total space to nonfood items.
Krogers business model has a major focus on combo stores, with a majority of its stores operating in the
combination store format.
Supercenters. The supercenters basic premise is to offer in a single location the merchandise mixes of both
a discount store and a supermarket/drugstore combination, often boosted by such ancillary services as dry
cleaning, banking, and restaurants. Supercenters average over 170,000 square feet and may devote as much as
40% of selling space to grocery products. For supercenter operators, such as Wal-Mart Stores Inc. and Target
Corp., food is a customer magnet that sharply increases the stores overall sales volume, taking customers
away from traditional grocery stores.
B02: Supermarket
fact sheet
SUPERMARKET FACT SHEET-2009
AVERAGE SUPERMARKET
Sales per supermarket (mil. $) 15.64
Square feet of selling area 33,250
Number of checkouts 9.6
Number of employees* 67
AVERAGE WEEKLY SALES ($)
Per supermarket 300,769
Per square foot 9.05
Per employee* 31,330
Per checkout 4,489
Per household 93.36
*Full-time equivalent.
Source: Progressive Grocer.
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Limited assortment supermarkets. Smaller than a traditional supermarket, limited assortment super-
markets typically carry fewer than 2,000 SKUs at very low prices. SUPERVALU Inc.s Save-A-Lot format
operates under a limited assortment format.
Other food outlets
Food stores that are not in the supermarket category include grocery stores, convenience stores, and
wholesale clubs. These stores may have selling areas of less than 5,000 square feet, annual sales of less than
$2 million, or a wholesale (nonretail) clientele.
Grocery stores. These stores sell mostly packaged and perishable food items, with a basic, narrow
selection of SKUs, and have annual sales of less than $2 million. Typically, these stores are privately owned
operations.
Convenience stores. These outlets usually carry about 800 to 3,000 itemsprimarily dry groceries, with
a limited selection of perishables (mostly dairy products), prepared foods, and general nonfood
merchandise; sometimes they sell gasoline as well. They typically offer very limited service and have margins
that are high compared with supermarkets. Examples of the convenience store format include the chains 7-
Eleven Inc. and Caseys General Stores Inc.
Wholesale clubs. A wholesale clubs format is a membership retail/wholesale hybrid with a limited
variety of products presented in a no-frills warehouse atmosphere. Averaging about 120,000 square feet of
selling space, warehouse club inventories consist of 60% to 70% general merchandise and health and
beauty care products, with groceries comprising the balance.
While wholesale clubs are open to retail customers, they sell merchandise in large sizes or bulk packs at
prices that are close to wholesale. These stores attract cost-conscious consumers and small business owners,
who are drawn by the low prices and multiple units of certain products. Dominant stores in this category
today are Sams Club (a division of Wal-Mart), Costco Wholesale Corp., and BJs Wholesale Club Inc.
Drugstores
Retail pharmacies are categorized according to the number of locations each has. Independent pharmacies
consist of three or fewer locations, while chains have four or more. In addition to competing with each
other, both compete with other formats that contain pharmacies, including supermarkets and mass
merchandisers.
Traditional chain drugstores. Averaging more than
8,500 square feet of selling space and employing an
average of about 25 employees per store, drugstores that
are part of a chain are much larger than independent
units. The average chain drugstore generates sales in
excess of $5 million per store. Although only about 60%
of total sales within chain drugstores are generated
through the pharmacy department, chains generate
nearly twice the pharmacy sales per store than do
independents.
Independent drugstores. Independent drugstores
average about 3,000 square feet of selling space and
employ about eight people per store. Total sales are
typically below $2 million per store, with about 90% of
that resulting from pharmacy sales.
Drugstore product offerings
Products sold within drugstores fall into one of two
categories: the pharmacy department or the front end. Pharmacy items include prescription drugs. Although
prescription items generate the majority of drugstore sales, the front end is a major focus of operators to
B04:
DRUGSTORE
PERFORMANCE
DRUGSTORE PERFORMANCE-2009
SALES & EARNNGS
Volume (bil. $) 301.5
Chain stores 226.1
% of total 75.0
% change from year before 7.4
ndependents 75.4
% of total 25.0
% change from year before 6.2
Average chain store sales per square foot ($) 745.0
Net-to-sales ratio (%) 1.5
Average volume per chain drugstore (mil. $) 7.5
Chain drug net earnings (bil. $) 3.4
STORES
Number of chain drugstores 24,560
Number of independents 19,852
Chain drug share of total drugstores (%) 55.3
Total square feet of selling space (millions) 276.3
Average chain drugstore size (sq. feet) 11,250
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generate additional growth. Front-end product categories include over-the-counter products, general
merchandise, health and beauty aids, and consumables. The largest drugstore chains also offer pharmacy
benefit management (PBM) services.
Over-the-counter products. The addition of over-the-counter healthcare products is the most logical area
for expansion: pharmacists are better suited to use their training and experience in the sales of these types of
products, rather than for cosmetics or photo services, for example.
Major over-the-counter product offerings include cold/allergy medicines, vitamins, gastrointestinal remedies,
internal analgesics, toothbrushes/dental accessories, first aid accessories and treatments, eye/contact lens
care products, sanitary napkins/tampons, antismoking products, diet aids, and foot care products. With
approximately 100,000 nonprescription healthcare products on the market, opportunities are plentiful for
category expansion.
General merchandise. While having the right location and a strong prescription business help draw traffic
to stores, strong merchandising helps create margin expansion. The top products that drive general
merchandise sales within drugstores are cigarettes, photography supplies, batteries, disposable diapers, and
home healthcare kits.
Health and beauty aids (H&BA). Drugstore operators have increased their focus on beauty care products,
both to develop a loyal customer base and to expand front-end profitability. CVS Caremark Corp., for
example, has relocated its beauty care products close to the entrance of its stores to capture the attention of
its core customers. Beauty care products include razor blades, cosmetics (eye, facial, lip, nail), deodorants,
fragrances, hair colorings, hand and body lotions, shampoos and conditioners, skin care products (cleansers,
anti-aging, etc.), and soaps.
Consumables. Operators are taking advantage of consumers propensity to buy impulsively by offering a
broad array of consumables at the front end of the store. The top products used to entice customers include
candy, beer/ale/alcoholic cider, carbonated beverages, wine, and milk.
Pharmacy benefit management (PBM). Large drugstore chains are increasing investment in their PBM
offerings to managed care and other organizations. These businesses allow large chains to take advantage of
strong growth in mail-order demand. PBM operations also offer specialty pharmacy services, plan design
and administration, formulary management, and claims processing.
EFFICIENCY IS A MUST
Supermarkets and drugstores have traditionally been low-margin businesses. Because of this and the
growing competition from the new formats described earlier, retailers must spend a great deal of energy
improving operational efficiency and profitability. Category management, a technology-driven approach, is
used to achieve efficiency in assortment and in managing merchandise.
Category management
Category management is rapidly becoming an accepted practice in the chain drugstore and supermarket
industries. By adopting it, retailers hope to offer a merchandise mix that will produce maximum profits.
The intent of category management is to provide a framework for evaluating the selection, arrangement,
promotion, and pricing of individual items to achieve the optimum product mix. Instead of offering 25
types of a certain product, the category management process might reduce the selection to 12ideally, the
12 that consumers want the most. This information is usually gleaned from point-of-sale (POS) data or, less
frequently, through customer surveys. By honing the stores merchandise assortment to offer products that
customers typically buy, shelf space is freed for other quick-selling or higher-margin items.
The retailers first step in implementing category management is to group similar products, such as
breakfast cereals, together as a self-contained business unit. A category manager, who works with suppliers
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to ensure that consumers get the products they want in the sizes and quantities that sell the best, runs each
business unit.
The category manager consults computer-generated data captured at the stores checkout. This information
reveals what sells the most, the fastest, or both, enabling the category manager to project how the product
or category will perform in the current market. To enhance sales, the category manager may employ
marketing, promotion, pricing, and merchandising strategies.
Retailers benefit from category management by having the right products on the shelves to draw customers
and make the store a more compelling place to shop. Retailers and their suppliers benefit from reduced
inventories, increased turnover, and improved profitability.
One size does not fit all
Although category management is important, merely refining inventory to emphasize top-selling items does
not make a store more attractive to consumers. Consumers respond not just to isolated product categories
but also to the store as a whole and what it offersits appearance, cleanliness, level of service, and
perceived value. Since consumer preferences vary from location to location and change continuously,
category management programs must constantly evolve to remain useful.
In selecting a mix of merchandise, it is important for a store operator to keep in mind the combination of
categories that the store carries, as well as the performance of an individual product or group. In addition, a
single items popularity can vary widely from store to store, or even within a single store according to the
time of day.
Thus, while technology and automation confer important advantages in todays competitive environment, they
must be regarded as toolsas means, not ends. It is important that stores not neglect the personal side of
merchandisingfor instance, the need for helpful sales clerks who know where items are located in the store.
Cost control is crucial
Because supermarkets and drugstores are low-margin businesses, controlling costs is critical. In both
industries, the difference between strong and weak players may be decided by a mere 1% difference in net
margins.
Product costs. Even the best managed supermarket and drugstore
operators must pay approximately 70 cents to 73 cents in product
costs for every dollar of their sales. Given the significance of
product costs for a retailer, sharp changes in food inflation or drug
inflation can have a significant impact on a companys profitability.
The quest for lower product costs has spurred a wave of industry
consolidation, as supermarket and drug operators seek to increase
their purchasing power over suppliers.
Labor costs. Food retailing is a labor-intensive business, and
employee costs represent the supermarkets greatest operating
expense. For supermarkets, labor accounts for more than 50% of
total operating expenses.
For supermarkets, labor costs are not as easily controlled as
operators might like. Unlike drugstores, many supermarket chains
are unionized, and their labor costs tend to be higher than those of
nonunionized competitors, making it harder for operators to keep
shelf prices competitive. This disadvantage has spurred supermarket operators to scrutinize every aspect of
their businesses to find ways to cut costs.
In the rapidly expanding drugstore business, companies may find it hard to fill all available pharmacist
positions, due to a shortage of candidates. Prescription volume is expected to grow more quickly than the
B03: Avg.
supermarket costs
as a % of sales
AVERAGE SUPERMARKET COSTS
AS A PERCENTAGE OF SALES
Total payroll 11.2
Employee benefits 3.6
Property rentals 1.8
Depreciation & amortization 1.4
Utilities 1.4
Supplies 1.0
Maintenance & repairs 0.7
Taxes & licenses 0.4
nsurance 0.3
All other operating expenses,
credit & allowances 4.3
Total operating expenses 26.3
Cost of goods sold 70.7
Profit 1.9
NOTE: Totals may not add due to rounding.
Source: Food Marketing nstitute
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pharmacist population through at least 2018. The Bureau of Labor Statistics lists 269,900 pharmacists in
2008 and projects there will be 315,800 in 2018, a 17.0% increase. Meanwhile, CMS projects prescription
drug spending is expected to grow at a compounded annual growth rate of 6.2% from 2008 through 2018
to $425.2 billion, nearly double the $234.1 billion spent in 2008.
As a result, many drug chains are using robotics to help improve the rate at which they can fill prescriptions.
They are also increasing the number of pharmacy technicians they hire. Technicians assist the pharmacist by
counting tablets, labeling bottles, and pricing and filling prescriptions, which must be checked by a pharmacist
before being given to patients. Technicians also may establish and maintain patient profiles, prepare
insurance claim forms, and stock and take inventory of prescription and over-the-counter medications.
When unemployment rates are low in many parts of the country, it can be particularly tough for these
labor-intensive businesses to find and keep reliable employees. Any increase in the minimum wage can affect
profits for both supermarket and drugstore operators because its difficult to pass this cost along to the
consumer. As a result, supermarket and drugstore operators have focused on reducing other operating costs
in attempts to improve expense ratios.
Other operating expenses. Marketing and advertising, rent, transportation, and utilities are also
substantial but controllable costs for supermarket and drugstore operators. Technology also is likely to
continue to represent a significant cost for drugstore and supermarket operators, as discussed later in this
section.
Collecting fees from manufacturers
Narrowly defined, slotting fees are payments from manufacturers to retailers for placing new products on
store shelves. This fee guarantees shelf space for the new products. It also subsidizes the retailers up-front
costs for adding the new product, and compensates the retailer in case the product fails to sell. Costs include
rearranging shelf space to make room for the new product, setting up accounting and computer systems,
placement and removal of new and old products, and evaluation of new product proposals.
There are other fees and services as well. They include retail capital improvement fees (contributions toward
the construction of new distribution centers or the installation of new store equipment); pay-to-stay fees
(upfront payments to guarantee shelf space for an existing product); volume incentives, promotional
allowances, and other rebates (price reductions with no connection to volume or performance); free-product
discounts; and failure fees (whereby a manufacturer must buy back unsold product from the retailer). In
some cases, a retailer may decide to carry a product based on the fees received rather than on consumer
needs. Such a choice can hurt the companys category management efforts.
Retailers have mixed feelings about slotting fees. Although some accept these contributions to their bottom
lines, more retailers are forgoing such short-term profits in favor of offering the right product mix, which
generates longer-term gains. There is also some thinking that as more volume is sold via mass merchandise
channels (i.e., supercenters), competitive pressures may induce conventional retailers to work more on a
coordinated partnership basis with manufacturersthat is, without fees.
Consolidations role
Drugstore and supermarket companies often find that it is cheaper to grow via acquisitions than to build
units from scratch. Mergers can mitigate certain risks of entering new markets, such as the lack of local
knowledge, the difficulty of attracting quality personnel, and the intensity of a competitors response.
Moreover, through consolidation, a supermarket or drugstore operator is able to generate economies of
scale, as well as added clout in marketing and advertising, procurement, distribution, technology, corporate
overhead, and private-label development.
OPERATIONS SHAPED BY TECHNOLOGY
To gain a competitive edge, many major drugstore and supermarket chains have invested heavily in
computer and telecommunications equipment. The installation of more efficient information systems has
enabled chains to improve inventory levels and to enhance their warehouse and distribution capabilities.
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Many stores are now linked together electronically, letting the chains headquarters tally sales for all
merchandise by store or by geographic region. This helps them keep pace with the latest industry sales
trends and ultimately to lower costs.
Other technologies include electronic labor scheduling systems, which match staff hours with customer
shopping patterns. Similar systems in distribution centers coordinate labor and equipment with arriving
freight. Satellite communication systems link headquarters and stores. Technologies that some retailers are
testing include electronic shelf tags, self-scanning checkouts, and even grocery carts with advertising-filled
video screens.
Perhaps the most important technologies used in supermarkets and drugstores are point-of-sale (POS)
equipment and quick response programs. For drugstores, pharmacy technology is crucial, as explained
below.
POS provides marketing info
Point-of-sale (POS) equipment is the sophisticated counterpart of the cash register that was introduced in
supermarkets in 1974 to improve efficiency and productivity. It was later introduced in drugstores.
Electronic POS scanners, which are linked to a computer network, read the universal product code (UPC)
labels on products. This information, detailing exactly what shoppers are buying, is captured and stored in a
database, where the retailer can study it. POS scanners also reduce labor costs and enhance price accuracy
by eliminating the need to mark items individually. From the customers perspective, scanners are beneficial
in that they reduce checkout time and generate a receipt detailing the type and price of each item purchased.
Only in recent years have supermarkets and drugstores begun to realize the potential of POS as a marketing
tool. By tracking each customers purchases and compiling the data, companies can analyze product sales by
size, color, and store. They can, thus, base their buying decisions on facts rather than conjecture, identify
the best-selling mix of merchandise, and assess the effectiveness of their promotions.
Quick response aids inventory management
To speed inventory replenishment and improve in-stock positions, retailers and their vendors have
increasingly adopted quick response programs. Taking a sell one, send one approach, quick response
seeks to maintain lean inventories, avoid overstocking, and ensure that retailers have on hand the
merchandise that customers want to buy. Through these programs, retailers and manufacturers are linked
via electronic data interchange (EDI). EDI speeds up the replenishment cycle by notifying vendors
immediately when new merchandise must be ordered.
Drug chains get wired
Like supermarkets, drug chains have adopted up-to-date technology, ranging from POS scanning setups to
computerized inventory management systems. However, because of the decisive role that prescription
medications play in the chain drugstores merchandise mix, these retailers also face the challenge of staying
on the cutting edge of increasingly sophisticated pharmacy technology.
The growth of third-party payment systems since the mid-1990s has spurred the rapid development of this
technology. Pharmacy operators face the pressure of handling an increasing number of prescriptions, while
the burdens of processing orders, dispensing medications, and billing threaten to degrade customer service.
Technology offers a tremendous opportunity to expand the pharmacists role in patient care. It allows the
pharmacist to ensure that consumers receive not only the correct drug in the proper amount, but
instructions regarding the intended benefits of the medication as well.
Sophisticated management information systems can link stores to insurers databases. This connection
enables stores to check customers eligibility and health plan parameters. It also allows the drugstore to be
paid directly for the amount not covered by the customers copayment.
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Automated dispensing machines and
picking systems can be tied into
management information systems to
enable pharmacists and technicians to
order, pick, price, dispense, and bill for
drugs more quickly and efficiently.
Many pharmacies are now installing
automated dispensing machines, giving
pharmacists more time to work on
drug utilization reviews, patient profil-
ing, and counseling.
FINDING PREFERRED CUSTOMERS
Customers who shop at retail
supermarkets and drugstores generally
fall into two groups. One shops by
comparing prices, trying to find the
best deals. The other is more loyal to
particular stores, believing that saving
time is more important than saving
money.
Store operators prefer to court the
time-savers, whose tendency to buy
merchandise at full price enhances
store profits. Increasingly, many stores
are trying to strengthen the loyalty of
the shoppers that they attract through
targeted marketing and/or customer
segmentation programs.
Many stores use loyalty or frequent
shopper programs to learn what these
customers want. These programs involve
issuing cards that customers can use to
get special discounts on certain items.
Whenever a customer uses the card, the
store tracks the purchases electronically.
The information gathered can be used to
compile a database that a retailer can use
to target its customers directly and cross-
promote other categories or items.
A retailer can use personal data
obtained from its customers frequent
shopper cards to segment its customer
base according to demographics,
buying patterns, geographic location,
and other variables. With this informa-
tion, the retailer can track customers
preferences and purchasing habits,
including which products they buy and
how frequently they shop at the store. Although virtually all chains collect personal data through frequent
shopper cards, not all use the information with the same efficiency. Some chains simply collect the data and
B06: SUPERMARKET
SHOPPING PROFILE
SUPERMARKET SHOPPING PROFILE
TRADITIONAL SUPERMARKETS
(Penetration: 99.1% of househoIds) TYPE AS %
TYPE AS OF DOLLARS
NO. OF % OF TRPS SPENT AT
TYPE OF TRP TEMS TO STORE STORE
Need it now, have to make a trip 1-5 47 17
Buying for a specific event (not routine) 2-10 14 12
Routine fill-in on heavy use categories 5-15 18 19
Prepare for the coming week 15+ 21.0 53.0
% CHG
FROM
SPENDNG YEAR AGO
Trips per shopper per year 55.8 2.0
Dollars spent per trip $29.15 1.7
Share of all retail outlet spending (%) 55.3 0.1
Share of volume sold on retailer deal (%) 34.7 1.6
Share of units sold on manufacturer coupons (%) 1.0 (0.1)
SUPERCENTERS
TYPE AS OF DOLLARS
Prepare for the coming week 15+ 21 17
% CHG
FROM
SPENDNG YEAR AGO
Trips per shopper per year 20.4 1.3
CLUB STORES
TYPE AS OF DOLLARS
% CHG
FROM
SPENDNG YEAR AGO
Trips per shopper per year 9.6 (0.2)
Share of units sold on manufacturer coupons (%) 0.1 0.0
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make no use of it, while others have
developed targeted marketing. Although
frequent shopper programs may
contribute to margin pressure through
lower prices for items purchased, they
can contribute to gross profits as
customers make more trips to the retailer
and/or increase the purchases made
during each trip.
KEY INDUSTRY RATIOS AND
STATISTICS
Real growth in gross domestic product
(GDP). Reported quarterly by the US
Department of Commerce, real GDP
measures the change in the nations
output of goods and services, adjusted for
inflation. Although the supermarket and
drugstore industries are viewed as fairly recession-resistant, the pace of economic growth can affect sales
growth and margins. Real US GDP declined 2.4% in 2009, and unemployment averaged 9.3% for the year.
Although Standard & Poors sees real GDP rising 3.3% in 2010, as of June 2010, the unemployment rate is
expected to continue to rise, to 9.7% for 2010.
Rate of growth in disposable personal income. Reported monthly by the US Department of Commerce,
this statistic measures growth in the average consumers income after taxes, adjusted for inflation. Because
products sold at supermarkets and drugstores are considered necessities, the volume of sales tends to remain
relatively steady during good times and bad. Americans disposable personal income rose 1.1% in 2009. As
of June 2010, Standard & Poors was forecasting a 3.4% gain for 2010.
Consumer price index (CPI). Compiled monthly by the Bureau of Labor Statistics, the CPI tracks retail
price inflation, or deflation, of various products. The so-called core CPI excludes volatile food and energy
costs. Analysts should focus on the CPIs food-at-home category to gain insight as to whether supermarket
operators have any pricing power. Because most companies generally try to pass on cost increases to
customers, the inflation rate for food prices influences food pricing. Food prices rose 1.2% in 2009, versus a
0.3% decline in the overall CPI. As of June 2010, Standard & Poors was forecasting a rise of 1.6% in the
overall CPI for 2010, with food prices up 0.7%.
Producer price index (PPI). This measure, compiled monthly by the Bureau of Labor Statistics, tracks
price inflation, or deflation, for raw materials used by US manufacturers. A rise in the PPI can force drug or
supermarket chains to pay more for inventory, pressuring margins if price increases cannot be passed along
to consumers. In the past few years, while individual components of the index have been volatile, overall
cost pressures facing US firms have been generally benign and have posed little threat in the near term. After
a decline of 8.7% in 2009, Standard & Poors is projecting that wholesale prices for processed food will
increase 2.1% in 2010, reflecting higher crude oil and farm product costs.
Interest rates. Although consumers pay cash for most supermarket or drugstore purchases, higher interest
rates can limit their spending. Interest rates currently are relatively low. Long-term rates, as indicated by 30-
year US Treasury bonds, declined to 4.1% in 2009 from 4.3% in 2008. As of June 2010, Standard & Poors
was forecasting that the long bonds rate would rise to 4.4% in 2010.
Table B05:
DRUGSTORE
SHOPPING PROFILE
DRUGSTORE SHOPPING PROFILE
(Penetration: 48.0% of househoIds)
TYPE AS %
TYPE AS OF DOLLARS
% CHG
FROM
SPENDNG YEAR AGO
Trips per shopper per year 13.2 (0.2)
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HOW TO ANALYZE A SUPERMARKET OR DRUGSTORE COMPANY
A good starting point for analyzing a supermarket or drugstore company is to understand the macroeco-
nomic environment affecting its business. Some of the measures for doing so are described in this Surveys
Key Industry Ratios and Statistics section. Next, it is essential to look at a range of qualitative and
quantitative factors, as discussed below.
QUALITATIVE FACTORS
Qualitative factors aid the analyst in assessing where the company stands relative to its competitors. To
make this comparison, several variables should be examined.
Store location
The key to success for a drugstore or supermarket is location. Areas with growing populations help to
ensure the long-term viability of a region for a company. In addition, if a site is in a wealthy community, it
may be more profitable, because residents will have more disposable income, and the store can emphasize
higher-margin products. One of the most important factors to consider is the level of competition from
other retailers. Chains that are more geographically diversified will be able to alleviate the risk of strong
competition or poor economics in any single market.
Market position
A supermarket or drugstore companys success hinges on its ability to secure a leading or dominant market
share. If a chain is not one of the top two companies in one or more markets, that does not necessarily mean
that it is a losing concern. Having the No. 1 or No. 2 position in any given market, though, may let a
company leverage its marketing and distribution costs. For drugstores, a dominant position may mean the
ability to win important third-party contract business and to negotiate more favorable reimbursement rates
with managed care providers.
As their industries have matured, many supermarket and drugstore chains have shed stores in areas where
they do not have a significant presence in order to focus their operations in regions where they do have a
commanding market share.
Service and amenities
Successful operators draw customers by providing high-quality service. Good service, coupled with an array
of amenities, can help boost a stores operating profitability. Amenities also appeal to shoppers. For this
reason, drugstores are implementing value-added services free of charge, such as in-store blood pressure
testing and flu vaccinations. Supermarkets offer specialty departments like pharmacies and florists.
Generally, service levels are known by reputation, but the best way for an analyst to determine how good
those levels are is to visit the chains stores.
Merchandising and store presentation
Merchandising involves deciding which items to buy and stock. Presentation involves strategies for
displaying items for sale, including store layout and dcor. Both elements are essential to a stores success.
Growth strategies
Having the right growth strategy is as important to a stores success as merchandising and presentation.
Growth is necessary because companies, prompted by their investors, generally want to increase sales and
profits. If a company selects the wrong growth strategy, however, it will end up losing money. In the past,
the easiest way to grow was to open new stores. Today, though, many companies have turned to
acquisitions to fuel growth.
Technology
In todays competitive environment, companies must be adept at gathering, analyzing, and using information if
they are to improve merchandising and distribution, expand customer service, and increase market share.
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Investing in information systems can help a company do this by tying its stores into supplier and vendor
networks, and by integrating its internal systems, which can streamline its workflow and reduce expenses.
The analyst should look for a company whose systems are integrated with those of its vendors. Integration
enables a company to be more efficient and to cut down on items being out of stock, which can hurt sales
and drive customers to competitors.
QUANTITATIVE FACTORS
The best place to find information to assess a companys quantitative health is on its financial statements:
the income statement, the statement of cash flows, and the balance sheet.
The income statement
The first step in financial analysis is to dissect the components of the income statement, also known as a
profit-and-loss statement. Retailing is subject to seasonal factors, so it is better to look at year-over-year
changes rather than comparing sequential results. When analyzing a supermarket or drugstore, analysts
should focus on the following income statement items.
Sales. At the most basic level, a company with sales that are steadily increasing is preferable to one with
stagnant or declining sales. Looking only at overall year-to-year sales changes, though, can be misleading. A
company that aggressively opens new stores can generate strong sales gains even if its stores are
unprofitable. Conversely, a company that is closing unprofitable stores may report lower sales, but its
financial health could be improving.
Same-store or identical-store sales measure sales in stores that have been open at least one year. Tracking
this number helps the analyst better understand a companys sales trends. In addition, sales per square foot
can be measured to determine the true profitability of a companys sales.
Gross profit margin. Gross margins are calculated as net sales minus the cost of goods sold, expressed as
a percentage of gross sales. Gross margins generally reflect a companys product mix and its operational
efficiency. Pricing and cost control have an important effect on gross margins.
Analysts should compare year-to-year changes and variances with other operators in the segment. For
example, a companys gross margins could be narrowing because of higher product costs. Such cost
increases, however, are also likely to affect its competitors. Price competition among operators also can hurt
margins as companies lower prices to defend market share.
Operating profit margin. Operating profit margins are calculated as gross profit minus operating
expenses, expressed as a percentage of total sales. Although companies define operating expenses
differently, the figure typically includes selling, general, and administrative expenses, and excludes interest
payments and other nonoperating expenses.
Because operating margins reflect costs that can be controlled somewhat, such as salaries, commissions, and
advertising, they are usually more easily controlled than gross margins. An increase in operating margins
usually indicates that management is using its resources more efficiently, allowing fixed costs to be spread
across greater volumes. Conversely, narrowing operating margins may be a warning sign that management
is not operating most efficiently.
Net income and net profit margin. Net income is calculated as operating profit minus interest payments,
nonoperating expenses, and taxes. In other words, it is the difference between total sales and total
expenseswhat is commonly called the bottom line. When net income is expressed as a percentage of net
sales, it is the net profit margin. Analysts like to see improving net profit margins. Excluding any special
items that can distort this number, such as extraordinary items, rising profit margins usually translate into
higher returns to shareholders.
!

Earnings per share (EPS). Generally defined as net income divided by the number of shares outstanding,
EPS is one of the key variables in financial analysis. Although management can manipulate this figure by
increasing or decreasing the number of shares outstanding, EPS is essentially the amount of profit available
to each stockholder. This number should be adjusted for special items so that meaningful year-to-year
comparisons can be made.
Price/earnings (P/E) ratio. The P/E ratiothe price of a stock divided by its annual earnings per shareis
one of the most widely used valuation measures. It is useful for comparing a company with others in the
same industry and other industries. The P/E ratio gives investors an idea of how much they are paying for a
companys earning power. Investors typically afford a company a higher P/E ratio if its earnings are
expected to grow more rapidly than those of its competitors.
The statement of cash flows
The statement of cash flows records all changes affecting cash for operations, investments, and financing. These
cash receipts and outflows are reported quarterly for domestic companies and are followed closely by analysts.
A companys cash position needs to be examined concurrently with its ability to generate cash, i.e., its free
cash flow. If a firm operates continually with net cash outflows because of working capital needs and
capital expenses, one should look to the cash level on the balance sheet to determine how long the company
can fund itself until it needs to tap the capital markets for financing.
Free cash flow, defined as a firms net income before depreciation and amortization minus capital
expenditures, often predicts the future health of a company. Low or negative free cash flow may impede a
companys ability to grow or may force it to raise capital (which can be costly) to continue operations. In
contrast, a company that generates strong free cash flow can use this excess cash to increase dividends,
repurchase stock, or repay debt.
The balance sheet
The balance sheet reports the major categories and value of assets, liabilities, and stockholders equity at a
specific time. Typically, investors welcome a strong balance sheet and avoid a highly leveraged one. The
important balance sheet items for supermarkets and drugstores are described below.
Return on capital invested. Return on capital invested is calculated as net income divided by the sum of
shareholders equity and long-term debt. Many companies use return on investment as the yardstick for
running their businesses. In simple terms, it is acceptable to borrow funds if the long-term return is greater
than the borrowing costs.
Inventory turnover. This measures the rate at which inventory is sold. It is calculated as cost of goods sold
(recorded on the income statement for a given period) divided by average inventory (recorded on the balance
sheet for the same period). Because some 40% to 50% of a drugstore or supermarket retailers assets may be
invested in inventory, this measure is a critical part of a company analysis. A high turnover implies that the
company is managing its inventory efficiently. This can result in higher gross margins.
Debt leverage. Debt leverage can be measured using two standard ratios: debt to shareholders equity,
and long-term debt as a percentage of total invested capital (the sum of stockholders equity, long-term
debt, capital lease obligations, and deferred income taxes.) There is no optimal amount of long-term debt
that a company should carry.
!
!
INDUSTRY REFERENCES
PERIODICALS
American Demographics
http://www.adage.com
Monthly; covers US demographic trends.
Chain Drug Review
http://www.chaindrugreview.com
Biweekly; covers events and trends pertinent to the growth
and development of the chain drugstore industry.
Chain Store Age
http://www.chainstoreage.com
Monthly; includes merchandising information, operating
techniques, training materials, and industry news for chain
store executives and store managers.
Drug Store News
http://www.drugstorenews.com
Biweekly; covers the drugstore industry.
Drug Topics
http://www.drugtopics.com
Semimonthly; covers topics of interest in the drug and
retail pharmacy business.
MMR
http://www.massmarketretailers.com
Biweekly; features stories on mass merchandisers, drug
chains, and supermarkets.
Progressive Grocer
http://www.progressivegrocer.com/progressivegrocer/index.jsp
Monthly; articles about grocery industry trends, companies,
and statistics.
Supermarket News
http://www.supermarketnews.com
Weekly; covers general supermarket industry trends, with
financial highlights.
TRADE ASSOCIATIONS
The Food Institute
http://www.foodinstitute.com
Nonprofit information and research organization that serves
the entire food distribution system, from seed companies to
grocery chains.
The Food Marketing Institute
http://www.fmi.org
Nonprofit organization that provides research, education,
and public relations services to its members, which include
food retailers and wholesalers, and their customers
internationally.
Grocery Manufacturers of America (GMA)
http://www.gmabrands.com
Represents food, beverage, and consumer product
companies at the state, federal, and international levels on
legislative and regulatory issues; leads efforts to increase
productivity, efficiency, and growth in the food, beverage,
and consumer products industries.
National Association of Chain Drug Stores
http://www.nacds.org
Represents chain-owned and -operated community
pharmacies.
Private Label Manufacturers Association
http://www.plma.com
International trade association of store-brand food and
nonfood products manufacturers and suppliers.
GOVERNMENT AGENCIES
Bureau of Labor Statistics (BLS)
http://stats.bls.gov
This division of the US Department of Labor is the federal
governments principal fact-finding agency in the broad
fields of labor, economics, and statistics. Among its major
programs are the consumer price index, the producer price
index, the employment cost index, and the national
compensation survey.
US Department of Commerce
http://www.commerce.gov
This cabinet-level departments mission is to ensure and
enhance US economic activity by working with businesses
and communities to promote economic growth. Its divisions
include the US Census Bureau, which publishes population
statistics and projections.
US Food and Drug Administration (FDA)
http://www.fda.gov
This division of the US Department of Health and Human
Services is responsible for supervising the food and
pharmaceuticals industries.
!

COMPANY INFORMATION
Many corporate filings with the federal Securities and
Exchange Commission, including 10-K and 10-Q filings, are
available through the commissions Edgar website:
http://www.sec.gov/edgar/searchedgar/webusers.htm

Quarterly and annual reports can also be obtained directly
from various companies. Some corporate information is
available at company websites. Such sites include:
BJs Wholesale Club Inc.: http://www.bjs.com
Costco Wholesale Corp.: http://www.costco.com
CVS Caremark Corp.: http://www.cvs.com
The Great Atlantic & Pacific Tea Co. Inc.:
http://www.aptea.com
The Kroger Co.: http://www.kroger.com
Rite-Aid Corp.: http://www.riteaid.com
Ruddick Corp.: http://www.ruddickcorp.com
Safeway Inc.: http://www.safeway.com
SUPERVALU Inc.: http://www.supervalu.com
Walgreen Co.: http://www.walgreens.com
Wal-Mart Stores Inc.: http://www.walmart.com
Whole Foods Market Inc.: http://www.wholefoods.comt
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